Deciding to Incorporate in India vs. the United States- a Difficult Decision

I am not sure what the right decision is, or even if there is a “right” decision.  But when I say we are incorporating in India, it is something that surprises most people.

The main reason we want to incorporate in India is that if we are working with Indian governments, having an Indian entity would be most conducive to that.   When the president of Kiva, Premal Shah, came and presented at our Hub Ventures class, he said that you should choose a legal structure which will help you scale most effectively.  For Kiva, it was a non profit (because the SEC legal issues would be crazy  if Kiva were to be a for profit entity).  For us, it seemed pretty simple.  If we get big (everyone wants to plan for success right?) Indian governments may not trust us if we are an American entity.  This would hold true even if we were an American company with an Indian subsidiary (like Microsoft does in India).  It could still potentially hinder our growth.

The downside: From what I understand, it’s harder to bring in investment capital from the United States.  I’m sure it’s not impossible, but it does make things more challenging.   India also has more strict tax laws (i.e. I believe corporate tax is around 15%-20% of profits, as opposed to the 1%-2% in the United States).

The Upside: There are a lot of Venture Capitalists in India, so it would make a lot of sense to get Indian money to invest in India.  We don’t have all the connections now, but hopefully when we are on the ground, we can make those associations.

The Neutral:  I believe bringing in grant money would be the same weather we are an Indian for profit, or an American for profit.

Also, the most popular type of incorporation in India seems to be an Limited Liability Company (as opposed to the C Corp or S Corp in the United States).  I wanted to make sure that I wasn’t taking on any personal Liability, so I asked our lawyer what the deal was with LLC’s in India:

 

“In India, the concept of limited liability is that the shareholders are only liable to the extent of the amount paid up on the shares and not beyond.  In a worst case scenario, the shareholders would stand to lose the amount invested by them in the Company but they would not have to shell out any funds from their personal resources to meet company liabilities.

Directors of companies cannot also be held personally liable for any of the Company’s acts/defaults etc, unless it is established that that such act/default etc is attributed to any gross negligence, misfeasance or breach of duty in relation to the affairs of the company.”

I.E. we are not going to be held personally responsible and it won’t ruin my credit score back in the United States (in the hopefully statistically improbable event that NextDrop goes Bankrupt).

If you are American and you want to invest in an Indian Company:

It’s a little bit tricky if you are not Indian and want to start a company in India, because our lawyer told us this:

“It is also pertinent to note that under the FDI regime, the allotment/transfer of shares to foreign investors would have to be effected at a price not lower than the price arrived as per the Discounted Cash Flow Method. [A1] [A1]“

Which raised the question: How does this work in practice?  Given that our project currently only has grant revenue, how would that restrict our ability to allocate shares?  We are considering allocating shares among co-founders with a vesting schedule that requires team  members to work for NextDrop for a certain number of years to receive equity.  Would this still be feasible?

The answer from our lawyer:

“In practice, most companies draw up projections for the next five years, assuming a particular growth rate.  In your specific case, maybe you can budget grant revenues for the initial two years (which in turn would typically depend upon the estimates of funds required in India and their respective draw-downs) and maybe you can then factor in some subsribtion/advertisement/service revenues for the next three years.

As regards the second part of the question, are you looking at an ESOP option?  If yes, then you should also probably consider drawing up an ESOP scheme, which would interalia include the manner in which the co-founders would acquire the ESOPS, te vesting period, the exit options, the mechanism for funding the exit etc.   Please note that in India, ESOPs are not very popular amongst closely held private limited companies primarily on account of the liquidity factor, since the shares of these companies are not freely transferable.”

 

Those are the things we came up with.  Hopefully we will be incorporated in India by the beginning of August.

If you have any questions, and/or feedback, we would love to hear it.